Gold soars past the $900 level to a new all time high of $915 per ounce and the dollar tumbles against all major currencies as markets increasingly expect an aggressively dovish Federal Reserve to slash interest rates by at least 75 bps in the next two months, with the probability of a 50-bp rate cut before the next meeting also rising. The deteriorating US macroeconomic environment and escalating erosion in the performance of major US banks has not only heightened certainty that US recession is already here, but also raises the odds that further declines in US interest rates will force the US dollar down in the league of low yielding currencies, thereby broadening the rally in metals and the rest of commodities. Citigroup, Merrill Lynch and Bank of America are expected to announce an aggregate $40 billion in Q4 writedowns, amounting nearly to 0.5% of GDP.

Rising Odds of Fed Cut this Week

This week’s busy data schedule will be dominated by a string of inflation figures from the US, UK and Eurozone but the more important data reports will be US retail sales, industrial production and Philly Fed index due on Tuesday, Wednesday and Thursday respectively. A dismal showing in these indicators coupled with continued selling in US equities will likely prompt the Fed into cutting rates as early as this week. With US equity indices testing their August lows and current macroeconomic dynamics knocking at the door of recession, we place the probability of 50-bp inter-meeting rate cut as high as 70% to occur as early as this week.

In the event that the Fed waits until its scheduled meeting later this month, a 50-bp cut on January 30 meeting will likely be poorly received by the stock market as well as the dollar. A possible obstacle to a Fed cut this week may be a higher than expected CPI report. Such a move would further propel the Aussie, Kiwi against the dollar, while dragging the yen across the board including the greenback.

With the 10-2 year yield spread soaring to a fresh 3-year high at 120 bps following Bernanke’s speech last week, the steepening of the yield curve means that the US fed funds rate may be cut by as much as 175-bps from its current 4.25%. We had originally been expecting 100-bps in Fed cuts for the year, but the resulting developments in the US yield curve following Bernanke’s overture to further easing are rising the probability of seeing interest rates dropping to as low as 2.75%. .

Yen Gains on Falling Global Investor Confidence

Yen gains across the board after Asian markets finished broadly lower following Friday’s losses in Wall Street. The rally in the Japanese currency is largely a manifestation of risk reduction plays rather than a vote of confidence of in Japan’s fundamentals. An inter-meeting Fed cut this week would be a positive surprise to global markets but a short-term negative to the low yielding yen. In such case, AUDJPY, NZDJPY and EURJPY are seen as the biggest winners in yen crosses.

Preliminary support seen holding at 107.60, but renewed losses are seen calling up 107.10, followed by 106.80. Resistance stands at 108.20, followed by 108.60. An inter-meeting Fed rate cut can potentially lift the pair to as high as 108.80.

Euro Soars on Rate Differentials

The euro lifted to a 7-week high of $1.4914, as US interest rates are set to drop below their Eurozone counterpart for the first time since October 2004. Prolonged expectations of a slowdown in the Eurozone increase pressure on the hawkish ECB to ease monetary policy, but as was seen in last week’s press conference, the central bank’s inflationary worries remains a priority, especially as Germany union pay demands are seek to make up for rising inflation.

The euro was boosted by the smaller than expected 0.5% decline in Eurozone November industrial production, yet the annual decline stands at its biggest since June 2007.

Caution must be paid at further euro longs as we expect losses to call up $1.4860, backed by 1.4820.Upside capped at 1.4930.

More Sterling Losses

Sterling’s weakness is highlighted by the currency’s tepid gains versus the damaged US dollar, as the pair reversed its climb to $1.9650, falling now to 1.9580. Last week’s declines in UK manufacturing output and production have rendered future BoE rate cuts inevitable. Tuesday’s release of UK December CPI is seen at 2.6% from 2.7%. Prolonged sterling losses are in store in the event of a lower than expected figure. Friday’s release of December retail sales will also be instrumental in further determining the case for further rate cuts.

Cable eyes support at 1.9520, followed by 1.9480. Upside seen capped at 1.9620. We continued to favor AUDGBP (0.4630 or 2.16), NZDGBP (0.4080 or 2.4510) and GBPCHF (2.1330).

Loonie out of Favor

The Canadian dollar extends its sell-off on the back of Friday’s bigger unexpected loss in payrolls and decline in Nov trade surplus. Today’s bigger than expected 2.9% decline in November vehicle sales adds to the string of poor data, including last week’s 9.9% collapse in Canadian building permits. Rising odds of a 50-bp Fed cut this month increase the possibility of a 25-bp rate cut by the bank of Canada next week. CADJPY had dropped below our projected target of 105.80, reaching 105.69 from Friday’s 106.20. AUDCAD hit 0.9170 and eyes 0.9220. USDCAD is seen capped at 1.0230. Support stands at 1.0130, backed by 1.0070.